Epiroc AB (publ) (OTCPK:EPOKY) Q3 2023 Earnings Conference Call October 27, 2023 7:00 AM ET
Company Participants
Karin Larsson – Head of IR and Media
Helena Hedblom – CEO
Hakan Folin – CFO
Conference Call Participants
John Kim – Deutsche Bank
Klas Bergelind – Citi
Max Yates – Morgan Stanley
Benjamin Heelan – Bank of America
Gustaf Schwerin – Handelsbanken
Christian Hinderaker – Goldman Sachs
Andreas Koski – BNP Paribas Exane
Anders Roslund – Pareto Securities
Anders Idborg – ABG Sundal Collier
Karin Larsson
Hello, and a warm welcome to the Epiroc Q3 Results Presentation. My name is Karin Larsson, Head of Investor and Media Relations here at Epiroc. As always, when we present the results, I have the pleasure to stand here with Helena Hedblom, our CEO, and Hakan Folin, our CFO. They will briefly present the results before we host a shorter Q&A session.
Helena, please, the stage is yours.
Helena Hedblom
So thank you, Karin. So hello, and a warm welcome from my side as well.
So, let me jump straight into the quarter. As anticipated, the demand in the third quarter was seasonally weaker than in the previous quarter. The demand and activity level remained high within mining and several large mining equipment, orders were won. Construction customers, on the other hand, remained hesitant and tentative.
So within mining, it was a particularly strong demand for automation and connectivity solutions, both for acquired solutions as well as for our own solutions. So in total, our orders increased 17% year-on-year to SEK14.4 billion.
In September, we announced our largest ever order, SEK700 million, to provide Kamoa Copper in Democratic Republic of the Congo with underground equipment. So after several years, with local presence and highly skilled and committed service technicians on site, the collaboration between Epiroc and Kamoa Copper has deepened into a real productivity and sustainability partnership.
And it’s especially exciting to contribute to the success of the Kamoa-Kakula Copper Mining Complex, as it is projected to be among the world’s lowest greenhouse gas emitting copper mines per unit of metal produced. Our revenues increased 17% to SEK15 billion, driven both by acquisitions and the organic development.
And our operating margin, EBIT, increased sequentially versus last quarter, but decreased year-on-year. It was supported by currency, but acquisitions, under-absorption, investments in R&D and marketing as well as product mix impacted negatively. And Hakan will elaborate more on the margin later, but I can assure you that we are taking measures where needed, while continuing to invest to remain a technology leader also in the future.
So with more advanced technology, automation, digitalization and electrification, it is more likely that we at Epiroc will also perform the service on the equipment, and this drives both revenues and profit. But the increasing number of service technicians in the field, comes with a great responsibility. We must continue to make sure all our employees always act with safety in mind.
And several actions have been taken to reduce injuries, and we have a positive trend in the development of our safety indicators. But that said, I’m very sad to share that we have lost a service employee in a fatal accident in the quarter. Safety is our top priority, and it is crucial that all Epiroc employees come home safe and sound, after the working day.
In my next slide, I would like to speak about that partnership is the new leadership. So this is something that I truly believe in. And the order I just mentioned from Kamoa Copper, is one good example. But there are more good examples, like our partnership with Newcrest, one of the world’s largest gold mining companies. In 2021, we announced that we created a semiautonomous production level in their Cadia mine.
And this project with mixed fleet equipment is developing well. And in this quarter, we now take our collaboration even further. So we will now take a holistic approach towards the entire mining processes at several of Newcrest mines, supported by Epiroc’s leading portfolio of automation, digitalization, and electrification solutions. So in short, it means that we share a vision on how to make the whole mining process more efficient and we will together invest, to finding the best solutions to do so.
Another collaboration we are engaged in is with Boliden and Algoryx and Orebro University, and the project includes the creation of a digital twin of a mine, a simulated testing environment for artificial machine learning, which greatly reduces the need for physical testing.
And speaking of reducing the need for physical interaction, do remember our Automatic Bit Changer, which enables hand-free bit changes and enhances productivity and safety, by eliminating human interaction with a drill string. So following the very positive customer feedback, we have now extended this solution to include a wider fleet of Pit Vipers. So please let me share a short video on the Automatic Bit Changer.
[Video Presentation]
So as a short refresher, I would like to remind you of our strategy. So we focus on attractive niches and outperformance, and the way forward is defined by innovation, aftermarket, and operational excellence, all of which rely on a foundation of a strong company culture and sustainability mindset. So innovation is to a large extent already covered today when I spoke about us being a productivity and sustainability partner to our customers.
And now I would like to cover the aftermarket, another very important part of our business. So it represents roughly 70% of our revenues in the quarter and includes service and tools and attachments. And within service, we see continued high activity, especially in mining. With an aging fleet around eight and a half years on average, we also see a strong demand for parts and for rebuilds.
For tools and attachment, the demand picture is more mixed. The largest portion of the revenues in tools and attachment, is rock drilling tools used both in mining and construction applications. And the demand there is good. The smaller, but more profitable revenue stream, is the hydraulic attachment, and here we see good demand for infrastructure projects, while the construction demand within housing and aggregates is lower.
Q1 and Q2 that are normally strong quarters for construction work, were weaker this year, and we see that the demand is still at low levels, and we anticipate that the construction demand will remain weak.
And this brings me to the next topic within our strategy, operational excellence. So, we are adjusting operations to remain agile and resilient, and we have taken actions and we will take more actions to improve our performance. So within production, we are adjusting to reduce under-absorption.
We’re also improving our manufacturing footprint, for example, moving production of low-profile machines from Orebro, Sweden to Johannesburg in South Africa. On the admin side, we continue with the rollout of our regional centers of excellence for finance and HR to improve processes, efficiency, and quality.
So coming then over to sustainability, as I said, always safety first. And as I said in the beginning of the presentation today, I’m very sad to report a service employee fatality in Kazakhstan in the quarter, and we are working with the customers and local authorities to investigate the circumstances around the accident. On the safety metrics, we do, however, see improvements and we have taken several actions, to reduce injuries even further.
On headcounts, we are still growing. We are now a little bit more than 18,000 employees in our Epiroc family and we have continued, to increase the proportion of women employees and women managers. We also have 1,800 additional employees that are also contributing to our progress.
On the emissions, we have managed to lower the CO2e emission from our operations for comparable units during the last 12 months with 26%, thanks to several initiatives including installations of solar panels and a higher share of renewable electricity. And the CO2e emissions from transport has however increased somewhat, which is explained by higher volumes delivered.
But as you all know, the emissions from us is mainly related to Scope 3, the use of products. So let me share an example of what our solutions can bring. In February this year, we finalized the acquisition of CR, and that has widened our portfolio to also include GET system. And GET is short for ground engagement tools. So with the right Cast Lip and GET system, customers can enjoy 10% more productivity while saving both energy and carbon emissions. So one bucket like you see in this example can reduce emissions by over 350 tons.
So with this, Hakan, over to you to cover the financials.
Hakan Folin
Okay. Thank you very much, Helena.
So I will start with the key financials, and sequentially, our orders were down, which was anticipated, as Q3 is normally a seasonally weaker quarter. But year-on-year, our orders received increased by 70% to SEK14.4 billion, supported by acquisitions, they contributed with 7%, and also by currency with 1%. The organic increase was 9%, but if we add back the removal of the Russian order book in Q3 2022, which was SEK1 billion, we had a flat organic development.
Customer activity remained high in mining. Several large equipment orders were won. Revenues also increased by 17% to SEK15 billion, and here we had an organic growth of 7%. Acquisitions contributed strongly by 9%.
Then a few words on our cash flow before discussing the margin on the next page. Our operating cash flow increased to SEK1.9 billion, and if we compare to the same period in previous year, it was supported by higher operating profit, however, negatively impacted from net financial items and also higher taxes paid.
Our operating profit EBIT increased by 12% to SEK3.3 billion, so it’s up from SEK2.9 billion last year, and I would argue that this is a meaningful increase. Items affecting comparability in this quarter were negative SEK12 million, consisting mainly of the change in provision for our share-based long-term incentive program. The comparable period in previous year included a provision of SEK150 million related to Russia.
Looking at the adjusted operating margin, excluding then items affecting comparability, it came in at 21.8%, down from 23.9% last year, supported by currency, while acquisition, investment in R&D and marketing impacted negatively, and also product mix and underabsorption in Tools & Attachment had an impact.
And looking at acquisitions more specifically, the dilution from them was 1.0 percentage point. As Helena said, we have taken and we will continue to take measures where needed within the organization to improve our profitability.
If we then go into the segments and we start with Equipment & Service. Orders received increased by 16% to SEK11.3 billion, with an organic increase of 9%. And if we adjust for Russia again, orders were down 1% organically. For equipment specifically, the orders received amounted to SEK4.5 billion, which corresponds to an organic increase of 14%, but if we adjust for Russia, in equipment, orders were down 5% organically.
Having said that, we still feel that investment sentiment among our customers continued to be strong in the quarter, and we won several large orders. In total, we won large orders of SEK1.1 billion, including the two announced orders from Kamoa in DRC and also Byrnecut in Australia. Last year in Q3, we had around SEK1 billion in large orders. So we are more or less on the same level this year as we were last year.
For our service business, orders received increased by 12% to SEK6.8 billion with a strong contribution from acquisitions. The organic growth was 5%, reflecting then a continued high activity level as well as a continued good demand for the large rebuilds that we do. And for service, if we adjust for Russia, service orders were up 3% organically. So our service business continues to perform strongly with a steady and solid organic growth.
Operating profit for Equipment & Service was up 16% to SEK2.9 billion, and here, higher revenues, currency, and acquisition contributed to the development. The operating margin was 24.5%, almost flat compared to last year, but then again last year, the margin was impacted by provisions related to Russia and for this segment, it was SEK138 million.
If we look at the adjusted operating margin, it was 24.4%, down from last year 25.9%, supported by currency. However, acquisitions impacted margin negatively, so did also the higher investment we’re doing in R&D and sales activities. And within this segment, the dilution from acquisitions was 1.1 percentage point. And as you can see, the adjusted margin is slightly lower than the reported one. That is due to release from an M&A provision in previous year of SEK7 million.
If we then move on to Tools & Attachment, here orders increased 17% to SEK2.9 billion, up 2% organically, and acquisitions, and this is mainly CR, which Helena presented previously contributed with 15% while currency was flat. And if we adjust for Russia, orders here were down 1% organically.
As we said before, the demand from the mining customer was good, but the demand from construction customers continued to be weak, and this impacts mainly the hydraulic attachment business negatively. Important markets such as Europe and U.S., they have a weaker housing and aggregates market. On the other hand, we see that infrastructure is holding up rather well.
On the revenue side, they increased by 18% to SEK3.2 billion, down 2% organically. Acquisition contributed with 19% and currency added another 1%.
For Tools & Attachment, the operating profit was down 6% to SEK481 million. The adjusted operating margin was 15.1%, down from 19.4%, negatively impacted by lower revenues and underabsorption, mainly in the hydraulic attachment business, and this in turn also impact the product mix negatively for this segment.
Currency contributed positively to the margin, while structure had a small negative impact on the margin. However, if you look in absolute terms, structure, which include acquisitions then, had a large positive impact. And in this segment particularly, we have already taken some actions and we will continue to focus on working smarter and more efficient going forward.
Then moving on to the next slide, which is on costs, net financials and tax. As said, we invest in our customer activities we invest in R&D in order to generate business and develop state-of-the-art solutions for our customers. Having said that, cost control is for us equally important. And here I believe that we can be more efficient on the costs side onwards, while we at the same time, continue to invest in our business.
Net financial items were SEK331 million, negatively affected by the exchange rate difference and also the net interest was up. It was SEK146 million, which is significantly higher than last year when it was only SEK23 million, which is explained by our higher debt and also by the overall higher interest rates. On average, our rate has increased from 2.5% and we are now north of 4%, and that makes a rather big difference. Income tax expense was SEK685 million and the effective tax rate increased to 23.4% from 22% last year. However, this is still within the guided range we have of 22% to 24%.
Moving on to operating cash flow, which has improved both sequentially, but also year-on-year. On the positive side, we have a higher profit and we also have less working capital buildup than last year, but we have a negative impact from higher financial items, taxes paid, and also investment. The cash conversion rate, which is calculated here on a rolling 12-month basis, was 55%, which is an improvement compared to the last quarter. I think we can do better here and we do expect better cash flow and better cash conversion onwards.
And let’s elaborate a bit on the working capital side. Compared to last year, the net working capital have increased 29%, and is now at SEK23 billion. If we exclude the effect of acquisitions and currency, it has increased by 25%. And the increase, I would say, is mainly explained by a long period of strong growth both in equipment and in service with corresponding higher level of inventories and receivable. And actually, a fairly meaningful portion of our inventory is equipment, either in transit or at our workshop, at our customer centers, on the way to be delivered to our customers. And I mentioned the so-called RORO capacity, roll-on/roll-off, within shipping. This is still an issue for us, and it limits our ability to get our equipment delivered to our customers.
Our implementation of the regional distribution centers is ongoing. This ties up a meaningful portion of our spare part. It continues, but we are seeing an improvement in our ways of working here. And you can rest assured that inventory management is a very prioritized topic for us. When we look at the total average net working capital in relation to revenues and also here on a rolling 12-month basis, it was up to 34.8%.
So finally from me, before I hand back to you, Helena, a few words on our working capital efficiency. We have a net debt position of SEK7.6 billion. Last year at this point, we were actually cash positive. So it’s quite a big difference, and the main explanation is the acquisitions that we have made.
If we look on the return on capital employed, we have been rather stable around 28%, if you compare to last year. But if you compare to two years ago, we were at 25%, so quite a strong improvement since then.
Okay. Over to you, Helena.
Helena Hedblom
Thank you.
So before speaking about the future then, I will briefly summarize this quarter. So safety is on the top of the agenda always, and we will continue to educate and work on improving safety, both for us and for our customers. We had continued high demand in mining in the quarter, and we landed several large orders, which is the result of good long-term collaboration with customers. I truly believe that partnership is the new leadership. Construction was weak in the quarter, while infrastructure had a stable development.
We delivered strong revenues, up 17% year-on-year, including a good performance from our acquisitions. And onwards, we will continue to focus on operational excellence while protecting and gaining customer share. The operating cash flow improved both year-on-year and sequentially.
And finally then, a few words on the near term. So we expect that the underlying mining demand, both for equipment and aftermarket, will remain at a high level, and that the demand from construction customers is expected to be soft. And I would like to emphasize that this statement is referring to underlying demand trends and not absolute order levels for us at Epiroc.
So thank you, and over to you, Karin.
Karin Larsson
Thank you, Helena. Thank you, Hakan.
So before starting the Q&A, I would just like to highlight the important dates for the next year, and especially, I would like all of you to mark your calendars for September 24 as we will host our CMD in Las Vegas in conjunction with the MINExpo, and that’s the largest mine fair in the world.
So operator, you may now open the line for questions. Thank you.
Question-and-Answer Session
Operator
[Operator Instructions] The next question comes from John Kim from Deutsche Bank. Please go ahead.
John Kim
Hi. Good afternoon, everybody, and thanks for the opportunity. Two questions, if I may. If we think about the near term, call it the next two to three years, how should we think about production levels and visibility, given issues in key end markets like Chinese construction and perhaps electric vehicles? A more pointed question for the shorter term, can you speak about what you’re seeing in underlying demand dynamics within hydraulic attachments? Thank you.
Helena Hedblom
I think if we start with the second one there, so on hydraulic attachment, we see solid demand for the portion of the products that goes into mining as well as infrastructure projects, while say, subsegments that is more related to housing and aggregates, that’s where we see lower demand. And if I look on it from a regional perspective, it’s the same trend in U.S., the same trend in Europe, as well as India, which are our main markets. I think on the – did I understand you correctly that when you asked about the, let’s say, the activity levels, it was more related to construction also in China for the coming years? Was that the question?
John Kim
And perhaps a little bit different. I mean, bulk of your business is driven by mining and copper is a key exposure. You’ve had good orders recently. But when you look at kind of key end markets for copper consumption, you could argue construction and perhaps China is a key use, and that looks to be trending negative. I’m just wondering if you’re seeing that feed through – part of the value chain?
Helena Hedblom
Yes. I would say on copper, yes, you know, I see what you are looking at there, but I think at the same time on copper, there are this supply demand gap that is also – will be there in the coming years, leading to that expansion projects will have to happen; also greenfield will have to happen to safeguard production output in the coming years.
So, I think that should also be taken into consideration, when looking at the overall demand as well as lower grades. I think copper, is also the commodity where we see that the grades are going down.
John Kim
That’s fair. Does that give you material advantage on pricing or utilization levels, the declining copper grade?
Helena Hedblom
Yes. And more complex, you need to go deeper. It’s more complex ore bodies and that is good for us, because that – it’s more advanced equipment needed, more safety aspects that you need to take into consideration, with depth et cetera. So, I think there are the overall – the underlying trends, are making it more difficult to bring up the same amount of metals in the coming years. And here, of course, also our technology solutions, helps our customers, to do the business at more difficult levels and more difficult environment.
John Kim
Okay. Helpful. Thank you.
Operator
The next question comes from Klas Bergelind from Citi. Please go ahead.
Klas Bergelind
Thank you. Hi, Karin and Hakan. Klas at Citi. So, my first one is on the underlying orders, actually SEK1.1 billion in large orders. The decline quarter-on-quarter ex-currency and M&A appears bigger than normal seasonality. And you say that the mining outlook is still solid, Helena, and you have indeed received obviously big orders, but just on the underlying side, are these sort of near-term push-outs of order decisions, because of higher funding costs, or are we having sort of construction exposure also within E&S, not only within T&A, that is sort of driving down orders a bit? If you could comment there, that would be very useful?
Helena Hedblom
Yes, I would say that that is the case. You are spot on. So we – of course, we also have equipment for construction applications and we see tunneling going strong. But at the same time, related more – the more, smaller machines going towards housing and demolition and quarries. There we see a softer demand, not only on the attachment side, but also on equipment. But when I look at the underlying activity levels, when I look at the age of the fleet, when I look on the pipeline, it’s still holding up well in mining.
Klas Bergelind
Good to hear. And when it comes to then, one for you, Hakan, the drop-through in Equipment & Service, the organic drop-through is now negative on high single-digit sales, which is a bit unusual. You talk about R&D, SG&A, under-absorption, but I’m trying to understand, what kind of drop-through we should model going forward, here next couple of quarters. You’re talking about potentially taking out cost here, to improve the leverage. Is this a short-term fix, or do you think that this is sort of the level, we should model here in the near term? Thank you.
Hakan Folin
No, I mean, we have, since I started at least, almost every quarter, showed a fairly good solid flow-through, and now this quarter was an exception. And this is an area where we think, that we can definitely do better. So no, we don’t want you to model in that, we’re going to have negative flow-through in the years going forward. That’s something we are – we are not happy with that performance and we aim to do it better going forward.
Then we’re not going to guide you on a specific level of exactly, what the flow-through will be. That was a difficult word to say, but we definitely think that we can do better than we did this quarter.
Helena Hedblom
And just to – from my side as well, we are not happy with our efficiency in the quarter, and we have already taken measures, to improve and we will continue to do so.
Klas Bergelind
And then Okay, thank you. My final one for you, Helena, on the service side, 3% growth in orders ex the Russia comp. I guess you still have pricing in that. So volumes are perhaps down a bit. We’ve seen miners struggling with production with some pent-up production demand having like – couple of quarters. But I’m curious here on the rebuilds, in the same way as we see the equipment push-outs, maybe not for you, but across the whole suppliers. Do you think there is a risk here that this can happen as well on the rebuilds or are you still seeing rebuilds being relatively solid?
Helena Hedblom
I would say rebuilds are solid. So I would say – I think I said the same last quarter, but with a big portion also – or big portion, but a bigger portion of our service revenues coming from these service products and rebuilds, and it can be variation between the quarters. But when I look at how much we’re landing when it comes to rebuilds, it’s a very solid level.
And I don’t expect that to be – to come down even if, there would be push-outs in decision for equipment moving forward. I don’t expect rebuilds to – that will not follow the same logic, because that’s an operational decision. So very often, we have seen that you do lodge your rebuilds actually, when the activity levels are lower in mining, because that’s also when you can do it in an efficient way.
Klas Bergelind
Thank you.
Operator
The next question comes from Max Yates from Morgan Stanley. Please go ahead.
Max Yates
Hi, good afternoon. Could I just start on the Tools & Attachments margin and the changes that you’re making? I think if I look back at sort of Q1, when you were last doing a 23% margin at group level, you were doing around 17% in the Tools & Attachments business. I guess my question is, how quickly would you expect, assuming we’re not getting a kind of big top line recovery anytime soon in Tools & Attachments. How quickly, do you think the changes that you’re making, will get margins kind of back up to what, I guess, we would consider, or maybe you would consider, a more normalized level? Is that something that happens in a quarter, or is that something that happens sort of going into 2024?
Helena Hedblom
I wouldn’t say in a quarter, but in a couple of quarters. Then, of course, this is – it is a mix effect. So of course, to adjust operations is one thing, but there’s also a product mix effect here. We have higher margins on our attachment business, than on the traditional consumables business. So, there will still be a mix effect, but I think the inefficiency that we have in the — in our, let’s say, operations in this quarter, due to the lower volumes, that of course, we’re addressing and addressing quickly.
Max Yates
Okay. And maybe just a follow-up. Could you help us a little bit with the actual sort of revenue split of your Tools & Attachments business? And I guess you talked about kind of the rock drilling tools was good, hydraulic attachments was a little bit weaker in construction. And the other business I was curious about, given Sandvik’s comments, they talked about their business sort of ground support, so sort of steel bars holding up mines, was seeing some quite negative price impacts. How big would that business be for you? As I kind of had a look, and it does look like you have some exposure here. And are you also seeing sort of similar pricing trends where Sandvik talks about their pricing being down about 10% in that business?
Helena Hedblom
So if we start with the first question, we have not shared, we’ll say, the exact split, but if I look on the total, the consumables business is the largest portion of TLD and the attachment business is the smaller one. So – but we have not shared, let’s say, the split between them. When it comes to rock reinforcements that is a small piece.
And I don’t see the same things happening on the pricing side. I think for – we are very focused on deep mines, with seismic activities where you have special solutions and where you can sell value, when it comes to rock reinforcement. So that’s the, let’s say, the offering we have towards rock reinforcement and that subsegment.
Hakan Folin
And if I may add, Helena, we also now have the fourth type of business within Tools & Attachment of the acquisition of CR, so the ground engagement tools as well.
Max Yates
And maybe just a really quick housekeeping question. I mean, just when you show that admin marketing and R&D expenses as a percentage of sales, and I look at it sort of year-over-year, it was 16% of sales in Q3 ’22. It was 16.1% in Q2 ’23, and it’s 16.1% this year, this quarter. I guess that’s not really much of a change. So should we sort of infer from that the actual size of the extra kind of investments on margin was maybe 10 basis points and actually it was the other issues that were bigger? Or is there some investments that maybe aren’t in this line? Could you help us size what the kind of impact was from that extra investment?
Helena Hedblom
But I would say rather that with the growth we have, we expect to have efficiency in admin. That’s part of our operational excellence initiative. We always strive for more efficiency on admin. So then, of course, we need that also to be able to continue to invest in product development and our presence. So for me, it’s more that, okay, we – with the increase in revenue, of course, we expect admin efficiency, and we have not seen that to the level that we expected.
Max Yates
Okay. Thank you very much.
Operator
The next question comes from Ben Heelan from Bank of America. Please go ahead.
Benjamin Heelan
Yes, thank you. It’s Ben from BofA. I wanted to come back on the order points because you talked about hesitation, and the orders do look as though they’re slowing on the OE side, and we’d heard some comments from some of the big miners about the current interest rate environment. So to your answer of the question a few questions ago, are you saying that on the mining side, you’re just not really seeing any impact at all from the higher rate environment on investments in the sector and it’s all about construction, or are you seeing that and it’s just been benefited by some of these large orders? I’m a little bit confused about the commentary on the mining side of things. And then secondly, if I can, around pricing in general, are there any big changes that you’re seeing from a pricing perspective across the business? Thank you.
Helena Hedblom
So we don’t see hesitations among our mining customers. And I think what we landed several large orders, as Hakan said, in the quarter as well above a billion, which is – that’s a big chunk of large orders. And when I look at the pipeline as well, and I think this is – but also, we need to remember that there’s also constantly a need for replacement, and the fleet every year now has grown older. So of course, you come closer also to that replacement need. So I don’t see that hesitation from the mining customers, but we see it on construction. So that’s why we comment like this.
On pricing, I have not – we don’t see any difference. We work with pricing always, and it’s always tied to our innovation and the value that we can create. So I wouldn’t say that we see any – we don’t behave in a different way than we normally do.
Hakan Folin
Where we have seen a hesitation, but that we mentioned already, I think already in Q1, but definitely in Q2, is on the exploration side, and then especially more for the junior exploration companies there, we saw – when interest rates started to go up, we started to see more hesitation.
Benjamin Heelan
Okay, great. Thank you. And just a quick follow-up on that. You said that Q3 was seasonally one of your smaller quarters. Should we assume there then that Q4 sequentially should see an improvement from an orders perspective? Is that how we should be thinking about the end of the year?
Helena Hedblom
I think as always, it’s – it all depends on large orders, as always, which is always lumpy. So it’s very difficult to predict when the large orders will come into the – into our books. So I would – when we comment, we comment on, we’ll say, the underlying activity levels. We cannot predict the large orders.
Benjamin Heelan
Okay. Very clear. Thank you.
Operator
The next question comes from Gustaf Schwerin from Handelsbanken. Please go ahead.
Gustaf Schwerin
Yes, hello. Thank you. Gustaf, Handelsbanken. I have a follow-up question on the leverage in Equipment & Service. So you have a similar share of service as a year ago. You’re mentioning the higher SG&A, R&D. Then I look at, for example, Q1 this year where you have a quite similar mix as in Q3, quite similar organic growth, even though a bit higher on the service side, at the same time, you have a larger increase in the cost year-over-year, but Equipment & Service is posting 35% leverage in like quarter, so I mean, I struggle a bit to understand why we are at such a low level now. Is it only the higher cost base year-over-year and lower growth versus Q1? Or is there actually some kind of negative mix effect within service or anything else? Thank you.
Hakan Folin
No, I wouldn’t really say there’s a negative mix impact. I think coming back to what we talked a little bit about before, is that we think that there are things also in Equipment & Service that we can do better than we did in this quarter, so not a really big mix impact. If you compare though to Q3 last year, a large portion of the change in the adjusted operating profit is coming from the dilution of acquisitions where we have made a few acquisitions within this segment and also they are growing quite nicely, as we showed, with 9% contribution to the revenue. But most of them, I would argue then, with a smaller, lower margin and thereby diluting the overall profit, but no real mix impact within the service part.
Gustaf Schwerin
All right. Thank you. And then I mean, just secondly, on the equipment deliveries, I mean, they look a bit low. Is this only outbound logistics? Because I got the impression before that we will not have much of a seasonal effect on deliveries for Q3. So it’s outbound capacity?
Helena Hedblom
It’s outbound, the RORO capacity, but on top of that, we also have, we’ll say, bottlenecks right now in our local modification in our service centers doing the local modifications. And one example is Australia, for example. So we do the loss modification from safety aspect in – according to local legislation, and there we have bottlenecks that we are addressing right now. But that has put – we’ll say, that has caused a problem when it comes to actually bringing because we are not happy with the output on equipment in the quarter. And if you – output from factories, yes, but not the output in the loss stage there. So that we are addressing as we speak as well.
Gustaf Schwerin
Just follow-up on that, because has that worsened quarter-on-quarter? Because I assume RORO capacity is probably a bit better in Q3 versus Q2.
Helena Hedblom
So this is more related to that these local modifications are competing with the same resources that we do rebuilds for – in the service. So it’s the same service workshops. So it’s – we have it in our own hands, and of course, it’s more assemblers that is needed. So this is pure capacity within our own organization, not really related to the challenges we have had previously on – of course, there’s still challenge with the RORO capacity on the outbound.
Let’s say, a big portion of why we have not really managed the output on the equipment in the quarter is that we have a bottleneck internally in our workshops out in the different customer centers, and specifically I would say in Australia.
Gustaf Schwerin
Okay. That’s very clear. Thank you.
Operator
The next question comes from Christian Hinderaker from Goldman Sachs. Please go ahead.
Christian Hinderaker
Yes. Good afternoon, Helena, Hakan and Karin. I just wanted to ask firstly on the margin headwinds, but maybe ask a little differently. You’ve cited marketing spend as one of the headwinds. I think that’s been a little more than SEK1 billion in the past two quarters, up around 28% year-on-year on sales growth of a similar number at around 30% this quarter. I’d assume that would have been from the return of travel spend and costs like that coming back after COVID, but then if you look back to pre-COVID, the average was more in the mid-600 million levels in krona terms. I guess not dissimilar actually as a percent of sales though, looks a little bit shy of 7%. So just interested in what is driving that sequential and year-on-year pickup in marketing expense. How should we think about modeling that relative to sales? Should there be some efficiency as you expand the top line? I’ll start there.
Helena Hedblom
Yes. So I would say that it’s mainly initiatives to improve, and of course, to – it’s both presence, it’s to capture the future growth, but I think when – for this quarter now, we are not in line with from an efficiency standpoint. So there is clearly things we can do to improve efficiency in marketing as well, and that we have already initiated that work.
So it’s – I would say it’s the traditional marketing and feet on the street, but also some larger projects that we have ongoing to understand and develop, let’s say, how to capture the future opportunities as well in certain parts of the world.
Christian Hinderaker
Thanks, Helena. Can I come back on inventories then? And specifically on the consumables side, I just wonder how we should think about your distribution model here. We know that you’re moving to regional hubs. Can I ask what proportion of your customers are leaning on your balance sheet to hold their spare parts and requiring sort of 24/7 deliveries relative to the proportion that might opt for vendor managed inventory? And then what is your outlook for channel inventories in terms of consumables in mining? Could there be destocking? We’ve heard a mixed picture in that sense from the supplier peers this week. So I’d be interested in your thoughts.
Helena Hedblom
So the setup we have is that we have created these regional distribution centers in the different parts of region – in the different parts of the world with then – and we have structured that network so that we can deliver both parts and consumables within 24 hours to the customers in that region.
On top of that, of course, when we have larger service contracts, we have consignment stock on the sites. So that’s very much the model, and that’s how we are operating both within parts and service and consumables.
When it comes to destocking, we see destocking happening within the infrastructure side. So I think a part of the lower demand there, it’s lower activity, but it’s partly also destocking. We don’t see destocking in the mining space. That’s not really the – let’s say, we have not seen anything like that within mining, but within construction and – because there also we use indirect channels and with indirect channels, that challenge can be there over time.
Christian Hinderaker
Thank you. And thirdly, maybe on the CR acquisition, you made that in the fourth quarter last year and it was a focus of the case study, but also a driver of some of the acquisition dilution to the margin. Just wonder how that integration is progressing. What are your broader strategic ambitions here as well in terms of growing out the ground engaging tools product family? Is that organic only or inclusive of M&A? And how should we think about the vertical integration of this business? Because if I’m not mistaken, I think you have your own foundry that you’ve acquired now, whereas the majority of the group is not vertically integrated to the same extent. Thank you.
Helena Hedblom
Yes. So we are very happy with the progress on the integration as well as on the synergies. So I think this was very good fit with Epiroc. When we look at the CR business or ground engagement tool business, it’s very much the same as Tools & Attachments. It’s a productivity offering, long contracts in the same way you sell it on TCO, and you create contracts, three-year, up to five-year contracts with our customers, which are very similar to the consumables business.
So of course, our ambition now is to grow this organically, I would say, mainly. And on top of that also, there is a nice suite of digital products that came with the CR acquisition that also now we can incorporate in the overall digital solution offering that we have at Epiroc. So very pleased with that acquisition.
When it comes to integration or vertical integration, yes, CR had one foundry, but that is a small portion of the actual total flow of these type of raw material into their business. Majority of the flow comes from external parts – parties, and that’s – I think it’s a very good model. An own foundry is crucial to be able to develop new steel grades and to make sure that you have the right quality, but also that you can lead from an innovation standpoint.
But we don’t have any, let’s say, further ambition when it comes to vertical integration. We believe in this asset-light model, and I think the setup with CR, it’s a good fit from an asset-light perspective with one foundry and not more than that.
Christian Hinderaker
Thank you, Helena.
Operator
The next question comes from Andreas Koski from BNP Paribas Exane. Please go ahead.
Andreas Koski
Thank you very much and good afternoon. Three quick questions. Firstly on your outlook, you are saying that you expect construction demand to be soft, but does that mean that you expect it to weaken further from the third quarter, or did you consider the underlying demand in Q3, to be soft and we are going to see the same kind of, underlying demand in the fourth quarter?
Helena Hedblom
It’s correct. So when we say soft, we already see it as soft, so not the same level as we have seen in Q3.
Andreas Koski
Okay. And then two questions just on the margin; firstly, on the FX impact. At current currency rates, do you see the same year-over-year margin support from FX in Q4, or was the margin support in Q3 sort of a one-off effect?
Hakan Folin
If I can answer that, in terms of FX, as you know, it depends both on the translation part, but also on the transaction part while – where the transaction part can be a bit more lumpy in terms of its revaluation of especially AP and AR on the actually balance day. And in Q2, we had a quite negative margin impact.
Now, in Q3, we had a positive impact. If you look – if you take year-to-date, it’s actually – it’s a rather small impact. Looking into – and now in this quarter, it was more on the transaction side, rather than on the translation side. And again, the transaction side is more difficult, to estimate what it’s going to be on the actual balance day.
But in terms of the translation part, as I mentioned, I believe when I started presenting, since the corona has been fairly weak for a long time now, if there are no major changes, the translation part, we would expect to be fairly limited in Q4. Then the transaction part that might vary more.
Andreas Koski
Okay. And then on the 250 basis points organic margin dilution, how much would you say come from mix and under-absorption, and how much come from R&D and marketing? The reason for asking is, because I guess, it’s easier to adjust R&D and marketing, than mix and under-absorption?
Hakan Folin
I think you can look at the two segments here and – because if you look on group level, yes, we have a — we have lower margin, and we have this negative organic. The main portion of that comes from the Tools & Attachment segments where, as we mentioned before, there we both have the product mix and also, we have the product mix, given the lower sales of hydraulic attachment.
And also the under-absorption, given that we have produced less. And I would add also its under-absorption not only, because the sales volumes are lower, but it’s also an effect that we are trying to reduce the inventory. So, we have also adjusted production from that point of view. So the majority of that, you can actually see in that segment. I think that hopefully explains.
Andreas Koski
Okay. Thank you very much.
Operator
The next question comes from Vlad Sergievskiy from Barclays. Please go ahead. Vlad Sergievskiy, Barclays, your line is now unmuted. Please go ahead.
The next question comes from Anders Roslund from Pareto Securities. Please go ahead.
Anders Roslund
Yes, hello. I had just one question regarding the bottlenecks you mentioned here in production. It seems that you hardly grew at all volume wise in the equipment area, given a 5% increase. And if you take away some price, it seems that there must be some bottlenecks, and that means also that you have higher inventory levels. How quick could you sort of address those issues? Could we see a better outflow in the fourth quarter and a better cash flow? Or is it a gradual process?
Helena Hedblom
Yes. So it’s – the bottleneck is not really in the production line – lines that we have. The bottlenecks are out in the customer centers in the workshops, where we do the final modifications, which means then that the machines are already in Australia or in Chile, which, of course, so you don’t have the lead time. And that, of course, helps when we sort of manage to open up these bottlenecks, revenue will happen quicker. So it’s not in the factories any longer.
The challenge is out in the customer centers in certain markets. But I expect improvements in the coming two quarters, I would say. I cannot promise that we manage, to do everything in one quarter, but over the coming two quarters, I think this one will be sorted out. So, I would say it’s a timing issue, but you’re correctly, this – correct, this is also, of course, leading to that we’re tying more inventory than we want.
Anders Roslund
Okay. Thank you.
Operator
The next question comes from Anders Idborg from ABG Sundal Collier. Please go ahead.
Anders Idborg
Yes. Good afternoon. Just love to hear your thoughts, I mean, it seems to be the same way for all the mining equipment companies now; orders for equipment are okay in Q3, but not at all at the same level as in Q1 and Q2. I mean, with the hindsight that we have now, do you think there – given that lead times are coming down. Do you think there was a bit of over-ordering still inflating the first half orders, to something that was just not sustainable? Or do you think that sort of the step down now, is more sort of junior miners et cetera are having issues with funding cost et cetera, or a combination of the two? I mean, what would be your thoughts on that?
Helena Hedblom
I don’t really – on the equipment side, we seldom see customers do speculation orders. I wouldn’t say that that is – maybe towards construction, that could happen, because there the contractors don’t – they don’t know if they will win or if they will lose something. And there they can of course gamble with an order. Within mining, I wouldn’t say that – we very seldom see speculation orders like that. We know our customers very well, and it’s either replacements or it is expansion.
And again, when we look at the orders received, also in Q3, roughly half of the orders for equipment relates to replacement orders and roughly half relates to expansion orders, and mainly then brownfield expansions. So, I wouldn’t say that there is, I would say, an impact of – that we saw pre-ordering earlier. I think it’s more timing issues and that will always be the case, when it comes to equipment, when they press the button to actually do the investment.
Anders Idborg
Right. So maybe the equipment orders that we saw in the first half, I mean, those could very well be repeated once the market normalizes et cetera.
Helena Hedblom
Yes.
Anders Idborg
Okay. Just secondly, I’m not sure if you mentioned it. Just an update on sort of the uptake of electric, uptake of battery-as-a-service, all of that. What kind of proportion you have now of order intake as electrified, that’d be useful? Thank you.
Helena Hedblom
So, we have not yet shared the, let’s say, the amount, not per quarter at least. We shared it in – when we had the Capital Markets Day, but I would say that it’s steadily improving. At the same time, it’s fair to say that the large orders, the customers that are – that want to go fully electric [technical difficulty] won’t be there another quarter. I think what is maybe more interesting is this, customers doing repeat orders, putting more orders in for one, two, three machines, et cetera.
Because that proves that they have tested it and they are convinced. It’s lower numbers in total. We don’t see these fantastic orders and we had – none of the large orders in the quarter were BEVs, but I’m more focused on these repetitive and smaller ones. Because I think that will be how you transform the industry, not just trusting these large orders and greenfield operations to go green.
Anders Idborg
That’s fair. Thank you for your time.
Karin Larsson
So already due to end this call. Thank you, Hakan, Helena. I know we have a few analysts still on the line. We have your names, and we will reach out to you after this call to make sure you get your questions answered. But for now, we say thank you very much, everyone, for taking the time today. And as always, we wish all of you successful investments. Thank you.
Helena Hedblom
Thank you.
Hakan Folin
Thank you very much.
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